The corporate veil is a fundamental principle of corporate law that separates a company's legal identity from its shareholders, protecting them from personal liability for the company's debts and obligations. However, in certain circumstances, courts may "pierce" this veil, holding shareholders personally responsible. This legal doctrine, known as "piercing the corporate veil," serves as a crucial check against the misuse of the corporate form (1).
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Understanding the Corporate Veil
The corporate veil refers to the legal separation between a corporation and its shareholders (2). This separation is a key benefit of incorporating a business, as it typically shields shareholders from personal liability for the company's actions or debts. However, this protection is not absolute.
“In the interests of justice, in an ‘appropriate case,’ a party wronged by actions taken by an owner shielded by the veil of a corporate shell may exercise its equitable right to pierce that screen and ‘skewer’ the corporate owner.” David v. Mast, 1999 WL 135244 (Del. Ch. Mar. 2, 1999) (3)
When the Veil Can Be Pierced
Courts may decide to pierce the corporate veil when they determine that the corporation is merely an "alter ego" of its shareholders or when maintaining the separation would sanction fraud or promote injustice (4). Some factors courts consider include:
Undercapitalization (5)
Failure to observe corporate formalities
Commingling of personal and corporate assets
Use of corporate funds for personal purposes
Fraud or misrepresentation
The Legal Test
While specific tests vary by jurisdiction, most courts use a two-pronged approach to determine whether to pierce the corporate veil:
Unity of interest and ownership (6): Is there such unity between the corporation and its owners that their separate personalities no longer exist?
Inequitable result: Would adhering to the corporate fiction result in fraud or injustice? (7)
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Implications for Business Owners
The possibility of veil-piercing underscores the importance of maintaining proper corporate governance. If you have partners, and the company is in litigation creditors may try to pierce the corporate veil. If they succeed, creditors can then go after all personal assets, bank accounts, investments, and other assets to satisfy the corporate debt (8).
Business owners should:
Keep personal and business finances separate
Maintain adequate capitalization
Follow all corporate formalities
Document business decisions and transactions
Avoid using corporate assets for personal benefit
Notable Cases
Several landmark cases have shaped the doctrine of piercing the corporate veil. For instance, in Anderson v. Abbott (1944), the U.S. Supreme Court ruled that shareholders could be held personally liable if they exercised complete domination over the corporation, using it to conduct personal business (9).
Growing Forward
While piercing the corporate veil is relatively rare, especially for publicly traded companies, it remains a powerful legal tool to ensure corporate accountability. By understanding the factors that can lead to veil-piercing, business owners can take steps to maintain the integrity of their corporate structure and protect themselves from personal liability.
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Disclosure:
The insights and recommendations provided in this series are based on extensive research and experience. However, every business is unique, and outcomes can vary. For a more personalized approach, consider reaching out to our team.
For those who prefer auditory learning or have accessibility needs, we're pleased to offer an audio version of this article. At Intenovate Inc, we believe in inclusivity and making knowledge accessible for everyone.
Sources
https://www.citybarjusticecenter.org/wp-content/uploads/2022/08/Publication-Piercing-the-Corporate-Veil-8.9.22.pdf
https://www.law.com/newyorklawjournal/2024/07/24/piercing-the-corporate-veil-finding-the-common-thread/?slreturn=20241014154551
https://www.gibsondunn.com/wp-content/uploads/2018/08/WebcastSlides-Alter-Ego-and-Veil-Piercing-2018-07-31.pdf
https://vrslaw.net/publications/understanding-alter-ego-piercing-corporate-veil-factors-implications-shareholder-protections/
https://vlaa.org/piercing-the-corporate-veil-a-legal-mechanism-for-accountability/
https://www.lawinsider.com/dictionary/unity-of-ownership
https://www.wolterskluwer.com/en/expert-insights/piercing-the-veil-of-small-business-what-the-owners-of-llcs-and-corporations-need-to-know#:~:text=Evidence%20of%20inequitable%20results,-A%20court%20will&text=This%20requires%20more%20than%20evidence,accomplish%20some%20other%20wrongful%20purpose.
https://www.firmtrak.com/legal-ramifications-of-piercing-the-corporate-veil/
https://vlaa.org/piercing-the-corporate-veil-a-legal-mechanism-for-accountability/#:~:text=Anderson%20v.,leading%20to%20an%20unjust%20outcome.
FAQs
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